Setting An Investment Strategy
Setting up an investment strategy can seem incredibly complex. You can find plenty of information on investing from the web, magazines, news sources, books, seminars, and even tips from friends. Unfortunately some people spend a great deal of time on investment strategies that are more likely to reduce rather than increase their investment portfolios. A study by Dalbar, a Boston investment research firm, found that from 1991 to 2010, individual investors saw average returns of 2.6 percent a year versus 7.7 percent of the S&P 500.
Personal investing can be quite intimidating!
But investing is not as hard as you may think. The best investment strategy is also a more simple investment strategy consisting of diversification, proper asset allocation and rebalancing. Studies have shown that these are the best approaches to maximizing your return while minimizing your risk.
Diversification reduces your risk by spreading your money among different types of investments. If certain investments classes decline in value, others can offset the losses by spreading the risk. The age-old adage “Don’t put all of your eggs in one basket” holds true today!
Asset allocation involves dividing your investment portfolio among different asset categories, such as stocks, bonds, alternative investments and cash. It is important to find asset classes that tend to react differently to the market’s ups and downs.
-U.S. and International Stocks have historically given high returns, but also come with higher risk and volatility.
-Bonds on the other hand have less volatility, but also offer less return. Examples are government and corporate bonds.
-Alternative Investments have become increasingly popular. Direct Partnership Programs (DPPs), Real Estate Investment Trusts (REITs), Oil/Gas, Gold and Natural Resources are some examples. Risk and reward differ based on the specific alternative investment.
-Cash is the safest investment, but offers the least amount of return of the four categories. Examples are money markets, certificate of deposits, and savings accounts.
Rebalancing your portfolio is critical in increasing your long-term returns. This reinforces investment discipline by selling an asset class when the price is high and buying more when prices for an asset class are low.
Maintaining a proper mix of each asset class is crucial for your portfolio. The proper mix should be determined by your time horizon and risk tolerance. Your time horizon is based upon the number of years needed to achieve your financial goals. Risk tolerance is your ability and willingness to lose the money you have invested in an effort to receive higher returns.
To determine your proper asset allocation, contact a professional financial advisor or use an online program such as Morningstar.com’s Asset Allocator to see recommended portfolios based on the information you input. The key to success is to be disciplined. Regularly re-evaluate and rebalance your portfolio when necessary to ensure long-term success!